Question

George Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down, and before the new building’s foundation could be constructed, a substantial amount of rock had to be blasted and removed. Because the office building is set back on the land far from the public road, George had the contractor construct a paved road from the public road to the parking lot of the office building.

Three years after the office building was occupied, George added four stories to the office building. The four stories had an estimated useful life of five years more than the remaining estimated life of the original building.

Ten years later, the land and buildings were sold at an amount more than their net book value, and George had a new office building constructed in another state for use as its new corporate headquarters.

Required:

Which of the preceding expenditures should be capitalized? How should each be depreciated or amortized? Discuss the rationale for your answers.

How would the sale of the land and building be accounted for? Include in your answer how to determine the net book value at the date of sale. Discuss the rationale for your answer.

Answer 1

1. A capital expenditure is an expenditure that gives a benefit for future periods. The cost incurred to acquire the land should be capitalized and classified as Land, being a non depreciable asset. Since tearing down the small factory is readying the land for its intended use, its cost is a part of the land's cost and hence should be capitalized and classified as land. As a result, this cost will not be depreciated as it would if it were classified with the capitalizable cost of the building.

Since Rock blasting and removal is required for the specific purpose of erecting the building, its cost is a part of the land's cost and hence should be capitalized and classified with the capitalizable cost of the building.This cost should be depreciated over the estimated useful life of the building.

The road and the parking lot are nothing but land improvements, and this costs should be capitalized and classified separately as land improvements. These costs should be depreciated over their estimated useful lives.

The added four stories is an addition and it should be capitalized and classified with the capitalizable cost of the building. This cost should be depreciated over the remaining life of the original office building because that life is shorter than the estimated useful life of the addition.

2. As the income has been realized whenever the earning process has been completed and a sale has taken place, a gain should be recognised on the sale of land and building.

The net book value at the date of the sale would be composed of the capitalizable cost of the land, the land improvement,and the building as determined above, less the accumulated depreciation on the land improvement and the building. The excess of the proceeds received from the sale over the net bookvalue at the date of the sale would be accounted for, as a gain in continuing operations in the income statement.